(Author’s Note: This post had an able assist from financial whiz Breton Birkhofer.)
Wow, talk about an inflection point. The International Energy Agency reported this week that global demand for gasoline has peaked. This new reality meets both the technical and popular definitions of an inflection point: a) the point at which the direction of a curve bends and b) a time of significant change in a situation.
Something is happening here and we know exactly what it is, don’t we Mr. Jones? The market is working. Through a complex set of climate-focused drivers that include regulatory mandates, price incentives and technological innovation, global aggregate demand for gasoline is declining.
Mind you, the IEA is plotting global demand for gasoline. While demand will continue to grow in developing countries as prosperity drives expansion of the middle class (pun intended), it will be significantly offset by demand reduction in developed, or OECD, countries through electrification of the fleet and better fuel efficiency.
Just a short time ago, it was a different picture.
I had the good fortune of working at Chevron for 10 years, from 2004 to 2014. When I came into the business in 2004, oil was selling for roughly $37 a barrel. Soon after, Forbes magazine ran a cover story, for which my company was a source, that carried the headline “Why $45 Oil Is Good For You.” The thesis of the story was that higher prices would provide oil companies with more capital to invest in increased production, ameliorating prices over the long-term. In fact, oil prices kept going up and hovered over the $100/barrel mark in 2011-12. There were a lot of factors that went into that price, but the fundamental truth was that supply couldn’t meet demand. That’s when Chevron started talking about the “new energy equation.”
But again, that was a global dynamic in which the explosive growth of India and China played a big role. On the other side of the world, as shown by the chart below, gasoline use in the U.S. started to peak around the 2014 time frame. And it has continued to go down ever since, as it has to a large extent in the U.K., Japan and Germany.
In 2020, the demand shock, compounded by the pandemic, was big enough to force the major oil companies to take a collective write-off of $105 billion as their asset prices plunged. There was even a brief moment in 2020 when oil prices fell below $0, meaning that sellers of oil were actually paying people to take it off their hands. Oil storage facilities were charging exorbitant rates to hold supplies until prices firmed up, which they started to do in early 2021.
Clearly, working in the oil industry isn’t for the faint of heart. But at least the path is clear: over the long term, gasoline demand is declining in the U.S. And if we zoom out, we’re seeing the same sort of inflection points in other energy markets. To paraphrase Henny Youngman, take natural gas, please.
Like gasoline, power markets are responding to regulatory and price signals and rapidly displacing coal as a power source with natural gas (which has about half the carbon content of coal). If you care about the climate, this is a good thing because the power and industrial sectors make up almost half of all greenhouse gas emissions in the U.S.
And like transportation, the industrial sector is becoming more efficient, so that the U.S. economy as a whole, measured by GDP, is becoming much less energy-intense measured by energy cost as a factor of GDP.
All of these metrics — gasoline demand, natural gas uptake, energy efficiency — are moving in the right direction in the context of climate change. The curve of U.S. greenhouse gas emissions relative to international targets is steadily moving down.
The point of all this is that markets are working. They’re responding to regulatory and price signals in meaningful ways and generating the right outcomes. In the renewables space, private funding is flowing into energy R&D at record levels; Amazon just started investing out of its $2 billion climate fund. And investors are buying battery SPACs like kids in a candy store.
We should keep all of this in mind as that rough beast known as the Green New Deal slouches out of Washington.
It will come. We’re seeing the Rooseveltian ambitions of the Biden Administration on full display in the scope of the American Rescue Plan. Next will come infrastructure, then will come climate. We don’t need to go into all the details of the Green New Deal as it was first introduced, but essentially it would leave no corner of the American economy untouched.
When the $2 trillion rough beast of climate legislation is unveiled and President Biden talks about our “narrow moment” to overcome climate catastrophe, just remember: the markets are working. Can we do more? Sure. A carbon tax, for instance, seems to be a pretty good idea to send a long-term price signal to the market. It would be fair and equitable without being disruptive. And it would tend to amplify the market forces that are already in place and having quite positive results.
The kind of trends we’re seeing in U.S. carbon markets today are only likely to accelerate, even if we do nothing. Adopting a Green New Deal, which would metastasize energy regulation, runs the risk of creating a level of economic disruption that would strangle growth. That, in turn, could create a wave of capital depreciation at a time when the country needs to expand its manufacturing and industrial capabilities.
So when the time comes, just remember: the markets are working. Let’s keep it that way.